By Gabriel Wildau and Lu Jianxin
SHANGHAI (Reuters) - China's stocks clawed back some of their recent heavy losses and cash markets steadied on Thursday, but gains were capped by concerns that last week's severe cash crunch was ushering in a period of tougher funding conditions and slower economic growth.
Authorities are alarmed that even as the world's second-largest economy continues to shift down from double-digit growth of the past decades, debt keeps rising and much of it contributes to a build-up of risks and financial imbalances with little benefit for productivity and economic growth.
As such, analysts think Beijing is even prepared to risk missing its growth target of 7.5 percent -- a two-decade low -- to drive home the message that banks can no longer rely on cheap cash to fund riskier operations.
"Policymakers apparently continue to believe that the ongoing cash crunch needs to last longer to achieve reduction of systemic financial risks," Dariusz Kowalczyk, senior economist with Credit Agricole in Hong Kong, wrote in a note.
Last week, the People's Bank of China (PBOC) allowed money market conditions to tighten and rates to soar, sparking fears of a credit crunch that roiled local and international markets.
It later moved to quell fears the squeeze could spin out of control into a full-blown financial crisis, but made it clear that cash conditions were being tightened and lenders should improve money management and lending practices.
On Thursday, the central bank opted not to drain cash from the money market, helping rates dip for a fifth day, while mainland shares, including battered financial stocks, opened higher for the first time this week.
Still, cash rates held well above long-term averages.
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The weighted average for the benchmark seven-day repo rate dropped over half a point to 6.74 percent, while the overnight rate was roughly steady at 5.57 percent. The weighted-average seven-day rate, which used to hover in a 3-4 percent range, peaked at a record 11.62 percent a week ago, though some trades were seen as high as 28 percent.
The gradual improvement helped the stock market, with the CSI300 index of the largest Shanghai and Shenzhen stocks up 0.2 percent by midday, though still down about 9 percent over the past week.
"We expect interbank rates will come down, but not to the same level as seen before the stress episode," Haibin Zhu, JP Morgan China Chief Economist, wrote in a note.
"The higher funding cost for banks could be ultimately passed through to borrowers. If lending rates are higher, it will put downward pressure on the already weak corporate sector and economic activity."
Several Chinese media outlets reported some branches of leading banks were either suspending lending to businesses and individuals or tightening and extending credit procedures.
It was not immediately clear, though, to what extent banks were already feeling the funding pinch and how much was a typical slowdown by banks that had already reached their end-of-quarter lending ceilings.
Responding to the reports, the nation's second-largest lender said it has not stopped offering new loans or lending to other banks.
"Currently, the short-term panic of the credit crunch has eased," China Construction Bank Corp <601939.SS> <0939.HK> President Zhang Jianguo said at the opening of the bank's first Taiwan branch in Taipei.
"CCB is operating smoothly. We are still capable of giving funds to other banks via interbank (loans)," he added. "We are not stopping giving out any new loans."
(Additional reporting by Yimou Lee in HONG KONG and Faith Hung in TAIPEI; Writing by Tomasz Janowski; Editing by John Mair)
